Last week was a pretty bad week for the Canadian banks. Scotiabank and TD Canada Trust, viewed by most as two banks least tied up to bad assets in the credit market, both reported larger than expected credit losses in its last quarter (a credit loss is a loan that cannot be collected). This has lead some to worry about whether Canadian banks will fail.

I wanted to address more the safety of the dividend in Canadian banks but, as a side-note, we really have short memories. TD, now seen as a leader in the industry, almost ran out of money in the 1990’s after some really bad bets in telecom. CIBC seems to be in trouble, oh, every 5 years or so (as I wrote before, its one of those businesses with trouble in its DNA based on its history). Everyone lost their shirts when Olympia and York went under in the 1990’s. So, in the much larger historical context, its a different day, different mess but its business as usual.

Having said that, I am one of those people who believe bank stocks are going sideways for 2 years and they are better cash flow generating vehicles via dividend payments than appreciation stocks. I also work under the assumption that no Canadian banks are going on an acquisition spree soon- valuations on banks are nearly impossible to predict and we are entering into an era of big government again where the idea of a foreigner company buying a major American financial institution isn’t going to go over that well.

Thus, the question becomes how safe is the dividend?

Historically speaking, the dividend payout ratio of the S & P 500 was 53% between 1960-1994 (in other words, 53% of profits were being paid in dividend). From 1995-2006, the dividend payout ratio fell to 42% which is very explainable since earnings went well above historically norms beginning in the late 1990’s (stats courtesy of Morningstar).

Now, if you assume that the word of investing is returning to some pre-dot com era of modest returns and reasonable valuations (p/e in the mid-teens and not 20’s), one would assume that dividend payout ratios would begin to creep back up.

Here are the dividend payout ratios of the Big 5 banks as of the opening of the market November 24 (keep in mind only BNS and TD have reported their earnings at the time of writing):

• BMO-63.49%
• BNS- 42.52%
• CIBC- n/a (CIBC is at a net loss for the last two fiscal quarters)
• RBC- 42.26%
• TD- 37.95%

It appears that you a have and have-not world. BNS, RBC and TD still have a ways to go before hitting historical dividend payout ratios. BMO and CIBC- well, the former may have to cut its dividend (if historical payout ratios are a guide) and the latter is eating into cash right now to pay out its dividend.

It would be safe to say that dividend increases are not happening any time soon. The question for BNS, RBC and TD are whether any future shocks are great enough to knock its payout ratio above 50%. For BMO and CIBC, the question is becoming how long can it hang on.

As usual, this is not a reccommendation to buy. Please do your own due diligence. And, please, please, don’t panic.

p.s. if you are wondering about dividend yields, here is an older musing about whether dividend yields are ove-rated (as usual, the comments from my readers are more interesting than my post).